You are in the process of buying a business. Should you include a restraint of trade against the seller?
A restraint of trade is a restriction on competitive behaviour by one party to the sale of a business, in favour of another.
It is common for an agreement for the sale of a business to include a restraint of trade clause. The standard form agreement published by the Auckland District Law Society includes such a clause.
The price payable for a business commonly in
cludes a component for goodwill. Generally speaking, the price payable for goodwill can be increased if the agreement protects the buyer from competition by the seller.
A restraint of trade will normally be for a certain time, usually a fixed period of months or years, and will cover a specified geographical area.
The key point to remember when negotiating a restraint of trade is to ensure that the clause is ‘reasonable’. To be reasonable, the restriction should be no longer in time, nor more extensive in area than is necessary to protect the buyer.
The assessment of whether a restraint of trade is reasonable will depend on the particular facts of the case. The following factors will be relevant when assessing the reasonableness of a restraint:
1. The strength and value of the connection the seller has with the customers or clients of the business;
2. The type of business carried on by the parties;
3. The size of the business;
4. The extent of competition in the fields in which it carries on business; and
5. The respective roles and skills of the seller and the buyer.
In certain circumstances, where there is no restraint of trade clause in the sale and purchase agreement, the Courts may be prepared to infer the parties’ intention to restrain the seller's trade.
In a case involving the sale of a general carrying business, the parties executed a written ‘conditions of purchase’ document which provided for two trucks being purchased by the buyer together with the goodwill in the business, and the disposal by the sellers of all the other vehicles. The document also provided for one of the sellers to commence employment with the buyer. The written contract did not contain a standard restraint of trade clause and was prepared without legal advice.
Six months later, the seller who had been employed by the buyer left his job, and together with his wife started up a general carrying business using two trucks which, contrary to the written contract, had not in fact been sold. The buyer sought a Court order requiring the sellers to cease business and dispose of the vehicles.
The Court held that the parties must have intended that the sellers would not compete against the buyer of the business within the sellers’ original area of operation. Accordingly, the Court granted the buyer an order preventing the sellers from operating in the original area of operation.
We strongly recommend that the parties to a sale of a business seek legal advice, and where appropriate, include a restraint of trade in the sale and purchase agreement, rather than gambling on a Court being prepared to infer a restraint of trade from the factual context.
Sam Williams, Associate
Commercial Business Team specialist
phone 834 6028
email sam.williams@nwm.co.nz
